MIKE TOWNSEND: The Olympic flame will be lit this weekend in Beijing, China, opening the XXIV Winter Olympic Games. The games are often a welcome respite from the tensions in the world, as athletes from around the globe gather to show their incredible skills and talents to a worldwide audience.
But these Olympic Games may only serve as a reminder of the delicate state of geopolitics in two of the most important countries in the world.
For China, this was supposed to be an opportunity to show its best side on the global stage. Instead, it will host a games with no international fans due to the still-potent COVID-19 Omicron variant. Numerous western countries, led by the United States, won’t send any diplomats to China in protest of the country’s crackdown on Hong Kong; its use of forced labor and re-education camps against the Muslim minority, the Uyghurs, in Xinjiang province; and its saber-rattling against Taiwan.
Meanwhile, on the ice and the ski slopes, Russian athletes will compete against Ukrainian athletes even as Russia masses more than 100,000 troops along the Ukrainian border in what many analysts worry is a preparation for an invasion.
Welcome to WashingtonWise, a podcast for investors from Charles Schwab. I’m your host, Mike Townsend, and on this show, our goal is to cut through the noise and confusion of the nation’s capital and help investors figure out what’s really worth paying attention to.
Coming up in just a few minutes, I’ll be discussing the Russian and Chinese geopolitical tensions with Schwab’s chief global investment strategist, Jeff Kleintop. We’ll focus on what a U.S. standoff with these two global powers could hold for the markets and the economy.
But first, let’s take a look at some of the issues grabbing the headlines here in Washington.
Of course, topping the news right now is last week’s retirement announcement by Supreme Court Justice Stephen Breyer after 27 years on the nation’s highest court. Breyer will stay on until his successor is confirmed. But this is a crucial opportunity for the White House to the shift the narrative after a tough couple of months.
Last November 15, President Biden signed into law the bipartisan infrastructure bill, one of his key domestic priorities. That law will inject more than $1 trillion into the economy over the next several years, building roads and bridges, expanding broadband access, boosting freight and passenger rail, and much more.
But since that victory, almost nothing has gone right for the president. The president’s other two key policy initiatives—voting rights legislation and the climate change and social programs-focused Build Back Better Act—have both collapsed in the Senate. Thorny foreign policy challenges have emerged, particularly as Russia threatens Ukraine. Inflation has rocketed to its highest rate in four decades. And as of the start of this week, the S&P 500® is down nearly 10% since 2022 began.
But this rare Supreme Court nomination offers a new opportunity for the White House to reset the narrative. President Biden hopes to use this as a spark to put the challenges of the last couple of months behind him and give Democrats something to feel good about with the midterm elections looming later this year.
The president has said he will nominate the first Black woman justice and that he will do so by the end of this month. Assuming a smooth confirmation process, by sometime this spring the president will get an historic moment.
It’s also an opportunity to put aside the infighting that has plagued Senate Democrats over the last several months. Presidential appointments are confirmed with a simple majority, and it is widely expected that all 50 Democrats—and likely some Republicans—will support the president’s nominee. President Biden has already seen 42 judges confirmed to the federal bench since he took office. That’s the most in the first year of a presidency since Ronald Reagan. Both Senator Joe Manchin, the moderate Democrat from West Virginia who squashed the Build Back Better Act, and Senator Kyrsten Sinema, the Democrat from Arizona who joined with Manchin in refusing to change the Senate’s filibuster rules in order to pass voting rights legislation, supported every one of President Biden’s judicial nominees to date, so there’s optimism at the White House that this streak will continue.
Of course, the new Supreme Court justice isn’t going to impact inflation, or come up with a slimmed-down Build Back Better Act that can pass the Senate, or know exactly how to respond to Russia’s aggression toward Ukraine. And the reality is that the president’s choice to replace Justice Breyer isn’t going to have a significant impact on the make-up of the court—the president will be replacing one justice from the so-called “liberal wing” of the court with another. Conservatives will still hold a six-to-three majority on the court that will allow them to shape the direction of American life in profound ways in the months and years to come.
The question is whether the president and the Democrats can use the momentum to break some of the internal logjams on other key issues before voters render their verdict in November.
The Supreme Court choice is not the only confirmation process that’s grabbing headlines in Washington. This week, the president’s three nominees to join the Federal Reserve Board of Governors will testify before the Senate Banking Committee in a joint confirmation hearing. It’s a process that probably matters more to the markets and investors than does the Supreme Court.
The president has tapped Sarah Bloom Raskin, who served on the Fed board from 2010 to 2014, to be vice chair for supervision, an important position that has broad authority over regulation of the nation’s biggest banks. He chose Michigan State University economist Lisa Cook and Davidson College economist Philip Jefferson to fill the other two open seats. If all three are confirmed, as expected, it would be the first time since 2013 that all seven seats at the Fed’s Board of Governors will be filled at the same time, and the first time in history that the Fed has a majority of women in those seven seats.
Expect Raskin to receive much of the Republicans’ ire during the confirmation process, as they worry that Raskin’s focus on tougher bank regulation could hurt the largest banks and the banking system in general. They also object to her calls for the Fed to do more to combat climate change, which some Republicans feel is an expansion of the Fed’s traditional responsibilities.
The president’s other two nominees, Cook and Jefferson, are far less well known in Washington and are expected to face less hostility at the hearing, though both may face questions about whether they have enough experience for the job.
Republicans will likely ask some tough questions of all the nominees, but, in the end, they cannot filibuster presidential nominees. As a result, Democrats need only to keep their 50 members together to confirm the three Fed governors. Unless something dramatic happens, Democrats are expected to stick together to ensure that happens.
The timing of a full Senate confirmation vote remains up in the air right now, but the quick confirmation hearing, coming less than three weeks since the president nominated the trio, means that votes could come as soon as late this month. If that happens, then the new governors’ first Fed meeting would be the mid-March gathering at which all indications are that the Fed will raise interest rates for the first time since 2018.
At the same time, the Senate also needs to vote to confirm Fed Chair Jerome Powell to a second four-year term as chair and to confirm current Governor Lael Brainard as vice chair. Those votes are also expected in the coming weeks, and both are expected to be confirmed.
Finally, there have been some interesting developments recently in the cryptocurrency space. The Biden administration is reportedly preparing to issue an executive order later this month outlining a government-wide strategy for digital assets. This is in response to a growing concern that while multiple federal agencies have been dabbling in cryptocurrency, digital currency, and stablecoin issues, there has not been any cohesive governmental strategy.
The executive order would reportedly call for various agencies to explore the impacts of digital currencies on the broader financial system; the risks that cryptocurrencies pose for money laundering and other kinds of fraud; the role of government-backed digital currencies in China and other countries; the impact on the U.S. dollar; and the possibility of the Federal Reserve issuing its own digital currency.
The Fed last month released a preliminary white paper on that idea and asked for public comments by May. In the report, the Fed did not take a position either for or against the creation of what is known as a “central bank digital currency,” or CBDC, but asked a lot of questions about the potential plusses and minuses of doing so. With other central banks around the world further along in the development of their own digital currencies, expect this paper and the comments received from experts on it to garner real attention within the Fed later this year.
Meanwhile, for investors interested in cryptocurrency, there’s been another setback at the SEC. The possibility of a Bitcoin exchange-traded fund was again shot down last week when the SEC rejected a proposal from Fidelity to launch the nation’s first Bitcoin ETF. The SEC cited insufficient investor protections and too much risk of fraud and manipulation to meet SEC standards—the same reasons it has cited in rejecting dozens of applications from asset managers over the last several years. So investors interested in a cryptocurrency ETF will have to wait a bit longer. And based on the SEC’s attitude so far, I’d say quite a bit longer.
On today’s Deeper Dive, I want to turn our attention to the other side of the world, where geopolitical crises are brewing in Russia and China. With these situations dominating world headlines, what are the implications for the markets? Should investors be concerned?
To help explore those questions, I’ve asked Jeff Kleintop, Schwab’s chief global investment strategist, to come back on the podcast. When it comes to international situations, Jeff’s sense of what matters and what doesn’t is, to me, extraordinarily valuable for investors.
MIKE: Jeff, thanks so much for coming back on the podcast.
JEFF: My pleasure, as always, Mike. Thanks for having me on your show.
MIKE: Well, Jeff, let’s start with Russia, because I think that’s the one that feels most immediate to investors. It seems like Russia’s antagonism towards Ukraine could still go in multiple directions. There could be a diplomatic solution, which very few people seem to think is realistic. There could be a full-scale invasion by Russia with the goal of installing a new government in Ukraine, which also seems unlikely. But there are a lot of potential outcomes in between those two extremes. So what do you think the markets are watching for? How worried are the markets—especially with Biden placing 8,500 troops on alert and the talks with NATO going nowhere?
JEFF: Markets do appear to be reacting to military developments in and around Ukraine. Russia’s stock market usually trades in sync with oil prices. But recently, as oil hits new highs, Russian stocks have fallen into a bear market, likely tied to the rising risk of a Russian movement of troops into Ukraine. Russia’s buildup of military forces around Ukraine is larger in scope than the exercises we saw back in March of 2021, and it more echoes the Russian invasions we saw in Georgia back in 2008 and in Ukraine in 2014. And, as in 2014, both the U.S. and NATO have communicated that they’re not considering the deployment of their forces to Ukraine to repel a Russian invasion.
Now, we know the human costs of military action are unmeasurable, but the stock market reaction to an incursion or an invasion of Ukraine may echo those of the past with little measurable impact for diversified investors. Previous incidents, looking back, those that involved Russia, they had little impact to the markets. Probably most similarly was Russia’s invasion and subsequent annexation of Crimea from Ukraine back in 2014, and that saw the S&P 500, and other developed and emerging markets around the world, dip less than 2% on the day it occurred, and rebound, at least partially, during the following five days.
MIKE: Well, Jeff, if something happens, it seems virtually guaranteed that the United States and the European Union would quickly impose sanctions on Russia. So what do you think those would look like?
JEFF: Well, “something” is a tricky word. What defines an invasion? What’s an incursion? Intelligence experts tell us the least likely possibility is a full-scale invasion. Instead, if Russia determines that it’s not receiving sufficient concessions on security guarantees, it might authorize the pro-Russia separatists in Donbas, Ukraine, to further increase the attacks on the Ukrainian government troops. And that could prompt the Ukrainian military to respond forcefully, allowing Moscow to justify a defensive Russian incursion into the area. Would that trigger sanctions? Probably, but it isn’t entirely clear.
In any event, it’s unclear exactly what these sanctions may end up being. The plans the United States has discussed with allies include cutting off Russia’s largest financial institutions from global transactions to hurt Russia’s businesses and imposing an embargo on American-made technology in order to try and exert pressure on Russia’s military and its consumers. But there isn’t anywhere near unanimous support for these measures among allies.
Russia is the U.S.’s 30th largest trading partner—that’s pretty far down the list. For example, the U.S. trades twice as much with Malaysia as it does with Russia. But that isn’t true for Europe. Russia is Europe’s fifth largest trading partner―it accounts for 40% of Europe’s gas imports. European officials worry that the proposed U.S. sanctions might prompt Russia to retaliate by cutting off natural gas and oil flows to Europe―something Russia’s done in the past to exert its influence.
Europe is very dependent upon Russia for its energy supplies and hasn’t been able to build up its reserves for the winter heating and energy demands. And while both the U.S. and other countries have already stepped up production to meet increasing shortages, supplies remain pretty tight.
So maybe instead of U.S.-led sanctions, a key lever for sanctions in Europe may be Germany’s willingness to halt the certification of the Nord Stream 2 pipeline, should there be an invasion of Ukraine. The Nord Stream 2 bypasses Ukraine in its delivery of natural gas from Russia to Europe, and that deprives the country of approximately $2 billion in annual transit fees Russia currently pays to use the Nord Stream 1 pipeline. And those tariffs contribute to this Russia-Ukraine hostility. The Nord Stream 2 pipeline construction was finished back in September, but German regulators have yet to issue the final legal permission Russia needs to begin operations. And Germany’s new chancellor, Olaf Scholtz, has said he may not approve it if Russia invades Ukraine.
MIKE: Well, sounds like there’s still a lot of uncertainty about how this will playout, but what do you think the implications for the U.S. and EU economies would be, particularly if we get into an extended standoff where the sanctions are in place for months?
JEFF: Yeah, they can be around for a while. First, Russia has taken great pains in recent years to minimize the impact of these types of financial and trade sanctions on its economy. They’re just … they’re used to them. You know, in 2014 sanctions were imposed by the Obama administration on Russia after its invasion of Crimea, and those remain in effect. Additional sanctions were imposed by the Trump administration after Russian meddling in the 2016 election―they remain in place. And further sanctions were applied by the Biden administration last year after the SolarWinds cyberattack, which exposed data from the U.S. government as well as hundreds of American companies.
Any further sanctions aren’t likely to have any meaningful economic impact on the U.S. due to, well, limited economic exposure and the fact that there’s been little impact on the U.S. economy from the sanctions I just mentioned. And U.S. exports to Russia are primarily agricultural, and they’re unlikely to have any measurable impact on the U.S. stock market indices.
Now, in Europe, the main economic impact is probably through energy prices, as I mentioned. But a lot of that impact to energy prices may already be priced in. Russia implemented some politically motivated supply cuts last year, and that really pushed up oil and gas prices in Europe, and they’ve contributed to high inflation, and they’ve weighed on growth there. To counteract this, the government in France, and others in Europe, have put freezes on consumer energy prices to try to lessen the impact.
MIKE: You mentioned that U.S. exports to Russia are primarily agricultural, but does a slowdown in U.S. exports to Russia have potential ramifications for other sectors or industries? And what about financial sanctions?
JEFF: Any financial sanctions are unlikely to be a material negative for banks outside Russia. The amount of trade with Russia in that is just not that significant. If we were to take things a step further, it’s possible the Commerce Department could issue a ruling that would essentially ban the export of any consumer goods to Russia that contain any American-designed or made with electronics―from phones to washing machines. And that would apply not only to American makers, but also to foreign manufacturers in Europe or in Asia that use American chips or software. This seems unlikely to be imposed, but if it were, and was enforced, it could marginally impact sales for these types of manufacturers.
MIKE: Well there’s definitely a lot to watch as this Russia and Ukraine situation unfolds. But let’s pivot now to China. One of the concerns I have been hearing, both from journalists and investors, is that a Russian move on Ukraine could somehow embolden China, perhaps depending on how strong the U.S./EU reaction is to a military action by Russia. China could potentially see a window of opportunity–with the U.S. and EU preoccupied with the Ukraine situation, they could move against Taiwan. Do you think there’s anything to that? And if it did happen, could the U.S. and the EU manage to deal with two huge international crises simultaneously?
JEFF: Well, on the surface there seem to be similarities between Russia invading Ukraine and China’s threats to invade Taiwan. But I think they are fundamentally different, and we shouldn’t assume anything about one from the other.
Unlike the situation in Ukraine, a Chinese invasion of Taiwan would most likely bring China’s industry to a halt as semiconductor shipments flatline and might provoke a sympathetic backlash in other Chinese territories and could bring global military action from Taiwan’s allies that are also dependent upon its manufacturing output. Additionally, Taiwan seems unwilling to make moves toward independence that would provoke China. You know, last summer, June of 2021, there was a survey conducted by Taiwan’s National Chengchi University, and it showed that only 31% of Taiwan’s population supported independence—that’s just not enough to empower Taiwan’s leaders to break away from China, despite the impression given by some of the recent headlines. Most in Taiwan still support the status quo, which is also China’s preference.
China’s officials have clearly stated the kinds of events that could push China to take military action against Taiwan in recent years. There are four of these, and the first one is any formal declaration of independence by Taiwan. That’s really unlikely, given the limited support for independence I just talked about in that survey.
Number two would be the end of any negotiations surrounding unification by all of Taiwan’s main political parties. But that’s also really unlikely since the Chinese Nationalist Party in Taiwan has a very friendly stance towards the mainland, and they wouldn’t cut off those talks.
Three, any kind of formal defense agreement with Taiwan signed by the U.S. or other Western allies. Now that’s possible, but the U.S. currently does not have such an agreement with Taiwan and isn’t likely to move, here in the near-term, to put one in place.
And then fourth, any widespread acceptance of Taiwan as a country equal to China in multiple international organizations, like the United Nations. You know, 50 years ago the UN admitted China and expelled Taiwan, and re-entry doesn’t appear likely in the near-term. So none of those things appear to be on the verge of happening, that would trigger a similar event in Taiwan.
MIKE: Well, Jeff, it sounds like there’s maybe a little overblown headlines on this situation, so that’s a really helpful perspective.
I want to switch gears to the Olympics, which are set to start in Beijing this week. What China thought was going to be two weeks of being in the spotlight is instead shaping up as a muted games. No foreign fans in attendance. Most of NBC’s coverage of the games here in the United States will be described by announcers in studios in Connecticut. We have rising Omicron cases in China; we even have U.S. team officials telling athletes to only bring burner phones that they can discard before coming home so that the Chinese won’t install tracking devices on their personal phones. It all sounds like kind of a PR disaster for China. So do you think this has any impact on the potential for a Taiwan situation—or maybe just the broader environment in China—after the games are over?
JEFF: It certainly isn’t the kind of environment that China was hoping for by hosting these winter Olympics, but, you know, I think back to last summer and Japan’s Summer Olympics—they were an embarrassment due to COVID restrictions and how Japan kind of mismanaged the whole situation. But Japan still saw the strongest fourth quarter economic growth anywhere post-games. So there may not be any lingering damage in China from this.
I think a lot of the coverage is on China’s zero-COVID policy and the costs of trying to have zero COVID cases. And I think it’s misunderstood. The dramatic lockdown earlier this year in the city of Xi’an, a city home to 13 million people, generated a lot of discussion about economic and supply chain impacts as China kind of clings to what appears to be an unobtainable and out-of-date ideal of zero COVID cases. But rather than thinking of this as a perfect example of that policy and its shortcomings, I think it’s actually the exception. Xi’an was the first large city to be put into full lockdown in China since the initial outbreak in Wuhan in early 2020. And the reason is that COVID measures are now highly decentralized, and other towns and even specific buildings and sections of ports have been mostly successful in controlling outbreaks without a major broad lockdown.
In fact, the authorities are confident enough in their ability to contain local outbreaks that they are not officially discouraging travel during the Lunar New Year holiday this year. You know, there are some guidelines, but the more relaxed policy should mean a stronger travel season and higher household spending in the first quarter than what we saw last year, if only marginally.
China’s zero-COVID strategy, that’s what it’s called by the west, but they actually refer to it there as “dynamic clearing.” And dynamic clearing is a compromise aimed not at snuffing out all the COVID cases, but effectively controlling COVID without hurting economic activity too much. It means that some areas may endure tough restrictions and disruption for a short period of time so that most of the country can exist without restrictions most of the time. Xi’an’s a big city but only makes up 1% of China’s population. Traffic plunged in Xi’an after the lockdown, but there was no visible effect on traffic in other cities.
So China’s policy has evolved, and the economic impact bears watching. I think they can manage the Olympics and Lunar New Year without a renewed economic downturn as long as they maintain their course on adding stimulus and cutting rates even as other central banks begin to hike them.
MIKE: Well, Jeff, let me ask you about another big issue that’s going on in China. Right before the holidays, Congress passed and the president signed into law the Uyghur Forced Labor Prevention Act. It’s a law that most people probably didn’t even take note of. But it was put in place because it’s now estimated that over 1 million people who are from Muslim minority groups have been sent to forced labor camps in China’s Xinjiang province. This new law bans imports from the Xinjiang region of China unless it can be credibly proven that the product was NOT produced with forced labor. Now, this new law still has to have regulations written to put it into effect, so it’ll likely be this summer before it kicks in, but it has a lot of implications not just for companies that import products from that region but even for asset managers, who will need to determine whether a company they’re invested in has ties to the region. Is there a material impact here for China’s economy and/or for any U.S. or multinational companies? Or is this just a strong but ultimately mostly symbolic gesture by the United States?
JEFF: Well, Beijing has been encouraging Chinese consumers for a year, over a year now, to move away from Western products and embrace domestic brands from sneakers to electric cars to you name it. And with Washington and the west increasingly focused on Uyghur suppression and similar issues, it’s likely Beijing will intensify that nationalistic campaign. You know, at the same time, there’s been an uptick in examples of China bashing foreign companies in the press, including Walmart, and Intel, and Amazon. Some of these companies sell more in China than they do in the U.S. For example, Intel gets 26% of its revenue from China, and if you add Taiwan to that, it comes to about 40%, compared to 21% of sales to the U.S. So companies may be forced to pick sides, alienating some portion of their global customer base in the process—or they can try and keep as quiet as possible, complying with the act while avoiding any announcements that could prompt a backlash by Chinese consumers.
MIKE: Well, Jeff, let’s wrap up with this. What are your takeaways for global investors who are growing increasingly anxious watching these two situations? Not only for the impacts they could make on the U.S. economy, but also on their investments in the EU if Russia uses the gas supply as a weapon. And what about their holdings that investors have in China? What’s your overall advice on watching these two situations unfold in the coming weeks and months?
JEFF: Well, Mike, I don’t think that diversified investors need to take actions to protect from the market risks tied to potential invasions in Ukraine or Taiwan.
Stepping back a little bit, European growth is set for a strong pace in 2022, well above average, despite the risks that include high energy prices that we talked about. And that should lend support to European stocks, especially with price-to-earnings multiples that are in line with the 20-year average, in contrast to the historically high valuations in the U.S. So far this year, despite the rising fears, European stocks have outperformed the U.S. market. Now a negative is that the higher gas prices climb the more utilities in Europe may suffer with an inability to quickly pass on those costs to consumers. But that’s just a small portion of the overall market.
In China, you know, the fate of Chinese stocks this year is tied to the effectiveness of stimulus putting a floor under 5% growth after last year’s regulatory crackdown on tech and property companies caused the economy to slow. So far it seems to be working, with China’s stock market among the best performers in the world so far this year.
MIKE: Well, great stuff, Jeff, as always. I really appreciate you taking the time to share your perspective with us.
JEFF: My pleasure, Mike. Thanks.
MIKE: That’s Jeff Kleintop, Schwab’s chief global investment strategist. Be sure to follow him on Twitter @jeffreykleintop. And check out his 90-second video on what he’s watching in the market each week. It comes out every Monday, and it is definitely worth your time.
Finally, on my Why It Matters segment, I like to note something interesting that’s happening in Washington that may have been below the radar screen and explain why I think it’s important.
It is very easy these days to bash Congress for failing to get much accomplished. The partisan divide on Capitol Hill seems worse than ever. A new poll reflected the frustration most Americans have with Congress: It showed that just 18% of voters approve of the job Congress is doing.
So I thought I’d point out one thing that Congress is doing that pretty much everyone seems to agree on—and that might actually have real-world impact.
Last month, a bipartisan group of senators introduced legislation that would create a federal grant program to help states combat financial fraud targeting seniors. The bill would provide $10 million in annual grants that states could use to fight back against scams that target senior investors. The money could be used to hire investigators, increase prosecutions, improve technology to track fraud and abuse claims, or conduct education campaigns to raise awareness about the problem. The program would be housed at the SEC. And the legislation has the backing of a wide array of consumer advocacy groups, financial institutions, and state securities regulators—groups that rarely agree with each other on anything.
The Senate bill matches a House bill that has already been approved by the Financial Services Committee and is awaiting a vote on the House floor. It seems very likely that the bill will be approved by Congress in the months ahead.
Now, in the context of the federal budget, $10 million is not that much money. The FBI estimates that people over 60 are scammed out of $3 billion annually. But $10 million to fight back against scammers is a start. And once this program is up and running, it’s going to be hard for a future Congress to get rid of it—after all, what elected official is going to say, “You know, we really need to kill that program that’s helping fight back against fraudsters who take advantage of elderly investors.” And maybe once this program gets off the ground, that $10 million becomes a bigger bucket in the future.
The bills in both the House and the Senate still have some hoops to jump through. But it feels like this is one of those times when both sides of the aisle will be able to come together to do something simple that could really matter.
Well, that’s all for this week’s episode of WashingtonWise. We’ll be back with a new episode in two weeks, so please take a moment now to follow the show in your listening app so you don’t miss an episode. And if you like what you’ve heard, leave us a rating or a review—that really helps new listeners discover the show.
For important disclosures, see the show notes or schwab.com/washingtonwise, where you can also find a transcript.
I’m Mike Townsend, and this has been WashingtonWise, a podcast for investors. Wherever you are, stay safe, stay healthy, and keep investing wisely.
